JAPANESE HYDROGEN GLOBAL ENERGY

JAPAN – KEY LINK IN HYDROGEN VALUE CHAIN THIS ARTICLE HIGHLIGHTS THE KEY CHALLENGES AND OPPORTUNITIES IN THE DEVELOPMENT AND FINANCING OF HYDROGEN PROJECTS AND THE PIVOTAL ROLE THAT JAPAN IS EXPECTED TO PLAY IN FACILITATING THE EXPANSION OF THE HYDROGEN VALUE CHAIN IN THE FUTURE. BY ETIENNE GELENCSÉR, PARTNER TOKYO, KARL PIRES, PARTNER TOKYO, JEAN-LOUIS NEVES MANDELLI, PARTNER SINGAPORE, AND NAOMI KING, CONSULTANT TOKYO, SHEARMAN & STERLING LLP.

March 11 2021 marked the 10-year anniversary of ammonia power generation could account for the Great East Japan earthquake that devastated approximately 10% of Japan’s energy supply by eastern Japan and triggered the shut-down of 2050. The key for Japan will be to unlock the the entire fleet of Japan’s nuclear power plants. opportunities that hydrogen presents at the scale Japan’s energy self-sufficiency has since remained and cost-effectiveness necessary to develop a at around 6%–7%, the second lowest among the viable “hydrogen society”. 34 OECD countries, with approximately 94% of its primary energy supply coming from imported Project development opportunities fossil fuels.1 One of the most exciting features of hydrogen This increased reliance on fossil fuels is its versatility as a product. Hydrogen initially brought with it an increase in can be used as a low carbon alternative or greenhouse gas emissions, hitting a peak supplement to natural gas and coal for heating of 1.41bn tonnes in FY 2013. Through the and electricity generation, for power storage expansion of renewable energy measures, the to complement renewable energy generation, reintroduction of nuclear power plants, and a as fuel for light and heavy vehicles, and as reduction in industrial energy consumption, an alternative to coke for steel production. Japan has been able to reduce its emissions There are also many existing applications for consistently over the past six years. In FY hydrogen as a feedstock for petrochemicals and 2019, emissions fell to 1.213bn tonnes, the fertilisers. Using green or blue hydrogen would lowest level since FY 1990 when data were reduce the carbon intensity for all of these first compiled.2 activities. Japan’s efforts to reduce its carbon footprint Significant investment is being made into are expected to grow. In October 2020, Prime hydrogen research and development globally. Minister Suga declared an ambitious goal for In Japan alone, there are ten hydrogen supply Japan to achieve carbon neutrality by 2050. chain demonstration projects in operation. Driven by this, the Ministry of Economy, Trade & This includes the Fukushima Hydrogen Energy Industry (METI) formulated a new Green Growth Research Field (FH2R)3, which uses a 10MW Strategy Through Achieving Carbon Neutrality electrolyser to convert renewable power from a that features five policy tools – government 20MW solar power unit as well as power from funding, tax incentives, transition finance the grid into hydrogen, which is then supplied to guidelines, regulatory reform, and international users regionally. collaboration – across 14 growth sectors within Various Japanese players are also involved the energy, transport/manufacturing, and home/ in cross-border hydrogen initiatives. For office industries.One of the high potential example, the Advanced Hydrogen Energy growth sectors touted in the Green Growth Chain Association for Technology Development Strategy is hydrogen. This is consistent with the (AHEAD)4 recently completed the demonstration message outlined in the Japanese government’s phase of the world’s first cross-border hydrogen “Basic Hydrogen Strategy” published in supply chain project. The demonstration December 2017, the first such strategy to be project was subsidised by Japan’s New Energy & announced in the world. To this end, various Industrial Technology Development Organization Japanese companies are developing technology (NEDO) and involved the production of hydrogen across the hydrogen value chain that can in Brunei5, its transportation to Japan in the potentially be utilised in a wide range of fields, form of MCH6, and its distribution in Japan including power generation, transportation and using Chiyoda Corporation’s SPERA Hydrogen® industrial manufacturing. technology. Chiyoda intends to progress the The Green Growth Strategy anticipates that project towards semi-commercialisation by the with successful implementation, hydrogen and mid-2020s.

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In parallel, Japan and Australia partnered that enabled wind and solar projects to make in the Hydrogen Energy Supply Chain (HECS) money. These schemes kick-started demand, Pilot Program7 to produce hydrogen from coal which led to rapid growth in both sectors and in Latrobe Valley in Australia and transport it economies of scale that eventually brought in liquid hydrogen form to Japan onboard the down prices to the point where they are now world’s first liquefied hydrogen carrier. This the cheapest forms of new energy in much of project recently commenced the Australian the world. arm of its operations and is expected to begin The Japanese government also recognises shipments in the first half of 2021. Itochu the need to lower the costs associated with Corporation also recently signed a memorandum hydrogen through economies of scale. METI’s of understanding with Air Liquide and Itochu 2019 Strategic Road Map for Hydrogen and Enex for the development of a hydrogen value Fuel Cells identified that the production cost of chain. hydrogen would need to be reduced to ¥13.3/Nm3 There are also continued efforts to increase (US$1.34/kg)8 (equivalent to US$10/MMBtu [CIF ammonia co-firing at existing power plants in Japan] of LNG9 on a calorific value basis, taking Japan. For example, consistent with the proposals into account environmental benefits of hydrogen) set out in the Green Growth Strategy, JERA has to make it cost competitive with conventional issued a roadmap for its Japanese businesses energy sources. In light of this, METI proposed that includes plans to achieve a 20% ammonia that by 2030 Japan would develop commercial- co-firing rate at all of its coal plants by the mid- scale hydrogen supply chains with the capacity 2030s and shift to using 100% ammonia at its to provide Japan with 300,000 tonnes/year of thermal power plants by the 2040s. hydrogen, and that this would help reduce the Despite the growing international consensus cost of hydrogen to ¥30/Nm3. METI’s long-term that hydrogen will play an important role in target of reducing the cost of hydrogen to ¥20/ the future energy mix and the technological Nm3 by further expanding Japan’s international advances being made by various players in the hydrogen supply chains provides a framework for market, developers will need to overcome certain developing the domestic market. challenges before hydrogen projects can be Hydrogen cost-competitiveness will be critical financed at a commercial level. from a financing perspective. Banks will want certainty that the commercial incentives that Key challenges drive the commercial structure are sound and • Cost competitiveness – One of the key remain constant or improve over time so that challenges in hydrogen development is financiers can provide long-term financing cost competitiveness. According to the solutions that are based on solid economic International Energy Agency (IEA), the fundamentals. production costs for grey hydrogen made from • Bankability and risk allocation – A hydrogen natural gas without carbon capture, use and project can take many forms. A green hydrogen storage (CCUS) range from US$0.9 to US$3.2/ project must be powered entirely by renewable kg, blue hydrogen made from fossil fuels with energy such as solar or wind power. Depending CCUS from US$1.5 to US$2.9/kg, and green on the target market, a hydrogen project could hydrogen made from renewable sources from also have elements of an oil and gas, chemical US$3.0 to US$7.5/kg. or mining project. As the structure of projects Hydrogen also has built-in inefficiencies as an in each of these sectors is very different, a key energy vector because more energy goes into the challenge from a financing perspective will production of the hydrogen than the hydrogen be in identifying and understanding the most output itself. The transportation of hydrogen – appropriate structure for the relevant hydrogen whether as ammonia, methylcyclohexane (MCH) project. Developers and their advisers will or liquid hydrogen – also adds cost for liquid therefore need to carefully consider how to hydrogen; transportation costs can be up to 30% present their projects to lenders, as this will have of the total hydrogen cost.While advances in a key impact on the terms available. technology will reduce the costs of hydrogen For example, the electricity supply aspect of production, it will take some time for low-carbon a project could be structured to replicate the hydrogen to be as cost-competitive as other risk allocation under a traditional power project fuels. Regulators will therefore have a key role including, in the case of green hydrogen projects, to play in providing the political and financial relying on intermittent wind or solar resources, support necessary to make low-carbon hydrogen which is a resource risk that lenders well commercially viable. understand. However, the offtake arrangements A parallel growth model that is often cited for hydrogen are considerably more complex. when assessing the future viability of hydrogen Currently there is no spot market, so structuring is the development of the solar and wind power could bear more resemblance to a long-term LNG/ industries in the early 2000s. At first, power gas offtake. generated from solar and wind technologies Moreover, the structure of a green hydrogen was simply too expensive to be used on a broad project will need to take into account the commercial basis; this was until governments intermittency of the renewable resource, brought in feed-in tariffs (and later auctions) which means it will be challenging for a

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hydrogen producer to commit to binding supply Insurance for Green Innovation, which provides obligations. There may also be features of LNG an increased commercial risk coverage rate of export projects that are relevant, such as the 97.5% and can be utilised for projects involving practical issues surrounding the shipping and hydrogen technology. transportation of hydrogen. Given the multi- The Development Bank of Japan (DBJ) has disciplinary nature of integrated hydrogen also expressed its commitment to growing projects, some sponsors may opt for a hybrid the hydrogen value chain. In February 2021, project structure like we might see in an as part of METI’s Green Growth Strategy, DBJ integrated LNG to power project. established a green investment promotion fund At present, a bankable hydrogen project is through which DBJ may invest equity in, or likely to need to involve a long-term offtake of provide mezzanine finance for, certain “green” low-carbon hydrogen to one or more existing businesses and projects including hydrogen. DBJ large-scale creditworthy hydrogen consumers. For was also involved as a research partner in the example, for the US$5bn Helios project located Brunei AHEAD project during its demonstration at the new city of NEOM in the Kingdom of Saudi phase, and has indicated its willingness to Arabia10, Air Products, the world’s largest supplier continue its involvement through to project of merchant hydrogen, is expected to be the sole commercialisation. offtaker of green ammonia (being the chemical carrier for the green hydrogen that the project Conclusion produces), which will be distributed to the global Hydrogen is increasingly recognised as one of market. the key elements in the global effort to reduce • Financing structures – Many hydrogen projects carbon emissions. However, the transition from currently being considered are scaled for captive an energy mix dominated by conventional local usage and thus the capital expenditure fossil fuels to a carbon-neutral energy mix in required to implement the projects cannot be which hydrogen plays a meaningful role will supported by asset-based financing structures. require the creation of a whole new market Developers often seek support from national and and the leadership of key industry players. regional government organisations to provide As one of the first supporters of hydrogen funding and subsidies for such projects. and with multiple demonstration projects in For the larger, more capital-intensive projects, development and operation domestically and we expect sponsors to be seeking non- or abroad, we believe Japan will play a pivotal limited-recourse project financing. Naturally, role in the creation of this new market and the such projects will need to demonstrate the unlocking of a vibrant and impactful global right economic fundamentals, such as low-cost hydrogen value chain. n renewable power (in the case of green hydrogen), strong offtake arrangements and supportive Footnotes regulatory frameworks. We also expect to see 1 - “Basic Hydrogen Strategy”, Ministerial Council significant export credit agency (ECA) and on Renewable Energy, Hydrogen and Related development finance institution (DFI) backed Issues (December 26 2017). funding, particularly in the early stages of 2 -“Climate Change – Japan’s initiative towards hydrogen project development. net-zero GHG emissions by 2050”, Ministry Of In line with the Japanese government’s Foreign Affairs (February 2021). hydrogen initiatives, we expect to see significant 3 - The FH2R project was developed by NEDO, interest in hydrogen projects by Japanese export Toshiba ESS, Tohoku Electric Power and Iwatani credit agencies and development banks, both Corporation. through debt financing and equity investments. 4 - AHEAD was established by Chiyoda For example, the Japan Bank for Corporation, Mitsubishi Corporation, Mitsui & Co, International Cooperation (JBIC) Act was and Nippon Yusen KK. amended in January 2020 to enable JBIC 5 - Shearman & Sterling LLP advised Brunei LNG to offer a range of financial products in on this project. support of its clients’ upstream, midstream 6 - Methylcyclohexane, or MCH, is a liquid and downstream hydrogen and low-carbon produced from toluene and hydrogen, which ammonia projects. Further, in January can be handled in a liquid state at ambient 2021, JBIC established the Post Covid-19 temperature and pressure. Growth Facility, which is available to fund 7 - The project partners consist of Kawasaki various projects that are expected to reduce Heavy Industries, J Power, Iwatani Corporation, greenhouse gases or contribute to preserving Marubeni Corporation, AGL Energy and the global environment, including hydrogen Sumitomo Corporation. projects. As part of its entry into the hydrogen 8 - Based on an exchange rate of 1 US$ = 110 JPY. industry, in 2020 JBIC invested, together with 9 - METI’s hydrogen roadmap noted that the IEA’s Mitsui, in FirstElement Fuel (FEF), the funds World Energy Outlook of 2018 forecast that LNG of which were used to expand FEF’s hydrogen prices in Japan would be around US$10/MMBtu station network in the US. (CIF Japan) in 2040. Similarly, in July 2019, Nippon Export & 10 - Shearman & Sterling LLP is advising NEOM Investment Insurance (NEXI) launched its Loan Company on this project.

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